Bankruptcy Reform To Impact Business

July 29, 2005
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GRAND RAPIDS — Purportedly, when major provisions of the Bankruptcy Abuse Prevention and Consumer Protection Act go into effect Oct. 21, it will be harder for people to walk away from debt and many will be forced to work out repayment plans instead.

Supporters of the new law say it will end the practice of people abusing the bankruptcy system. Opponents say it will hurt the economically vulnerable.

The number of non-business bankruptcy filings has risen dramatically, from about 300,000 in 1980 to nearly 1.6 million in 2004. Chapter 7 and Chapter 13 personal bankruptcies filed in the 12-month period ending Dec. 31, 2004, totaled 1.59 million, according to the Administrative Office of the U.S. Courts. That’s down from 1.66 million in 2003 but up from 1.5 million in 2002.

Chapter 11 business bankruptcy filings totaled 34,317 in 2004 and were down 2.1 percent from 2003 totals.

The Federal Deposit Insurance Corp.’s most recent state profile for Michigan (Summer 2005) indicates that Michigan has a rising per capita bankruptcy rate relative to the nation. The rising bankruptcy rate here, according to the FDIC, demonstrates a greater degree of financial stress on Michigan households. The agency suggests that the new law may result in an increase in filings prior to the law’s effective date in October.

Judge Jeffrey R. Hughes of the U.S. Bankruptcy Court for the Western District of Michigan said the most recent reports on bankruptcy filings show an increase in Chapter 7 personal filings in comparison to the number of filings last year, but whether it’s attributable to the impending amendments becoming effective, he doesn’t know.

Under the new law, an individual will no longer be free to choose which type of bankruptcy procedure he wishes, and many will no longer be eligible to file for Chapter 7. There will be a “means test” to determine whether an individual qualifies for Chapter 7 or Chapter 13.

A debtor has to itemize personal living expenses according to IRS standards for delinquent taxpayers. Under Chapter 7, after forfeiting certain assets like investments, the petitioner’s debts are erased. People with insufficient assets or income — people whose income falls below the median income for their state — would still qualify for Chapter 7.

The vast majority of people who file for Chapter 7 are already below the median income, so the means test won’t affect them, said Attorney Robert Wardrop, a principal of Wardrop & Wardrop PC. “But to the extent that someone is a little more well off, what it’s going to do is either force them to, in effect, cut their standard of living to the IRS guidelines or they’re going to avoid filing Chapter 7 and go underground.”

Attorney David Andersen, owner of Andersen & Associates,said that in his 25 years of bankruptcy experience, he has never met anybody that went into debt with the idea that they could just walk away from it by filing for bankruptcy.

“The myth is that if you make bankruptcy tougher, people aren’t going to overdo their spending,” he remarked. “Nobody wants to be in this position. These people are here as a last resort; bankruptcy is their only way out.”

Historically, medical expenses tend to be the No. 1 reason people are forced to file for bankruptcy; job loss is the second-most common reason and divorce the third.

In the case of a debtor whose income is higher than the median, the court will be required to apply an income-based test to measure the individual’s ability to repay a substantial portion of the debt. If the debtor is able to pay a minimum of $100 a month for five years, purportedly he will be forced into Chapter 13 and put on a repayment schedule. The reform also requires that a debtor meet with a credit counselor before filing for bankruptcy to determine what non-bankruptcy options there might be.

“The idea there is more to make sure the debtor is making an informed decision,” Hughes explained. He said the reforms do not fundamentally change the underlying principles of bankruptcy — that the debtor is to receive a chance to “catch his or her breath” and get a fresh start through administration of the bankruptcy laws.

“The objective in the context of the classic Chapter 7 bankruptcy proceeding is that the debtor is still entitled to a discharge of his or her pre-petition debt unless there is an exception,” Hughes observed. “There’s a little bit of whittling away of that, but as a general proposition it’s still the same concept.”

Generally, what has changed is that the amended law gives the various interested parties — the secured type creditors or lessors — more advantage in the bankruptcy process, he noted.

With all individual filings, a “tremendous” amount of documents will have to be produced within a very short time of filing, unlike the old bankruptcy law, Andersen pointed out.

“This is going to be very expensive. Even for the simplest of cases, fees are going to go up, because the attorney is going to have to spend a lot more time with the debtor and the client going through voluminous records and documents.”

Wardrop said the new law wasn’t designed to have an impact on Chapter 11 business bankruptcies, but it will — and it will be far greater than most people were led to believe.

Though the qualifications for Chapter 11 haven’t changed, there’s a whole new provision for small business bankruptcies in the code, and the legislation is going to make Chapter 11 a little more difficult to administer, Wardrop said. Under the old code, there was a small business plan, but almost everybody opted out, which they could do automatically, he explained. Under the amended code the debtor company can only opt out with the court’s permission.

“It may be harder for them because they’ll be under stricter time deadlines than the normal Chapter 11,” he noted. So tighter deadlines and greater scrutiny applied under the new law may make it more difficult to reorganize under Chapter 11. The law takes away much of the court’s discretion, as well, Wardrop pointed out. 

“Under the old code there were no absolute guidelines. The court could extend time periods for good cause. The new provisions — especially in the small business area — set absolute deadlines that neither the court, nor the parties themselves, are able to extend.

“The law really is not friendly towards small businesses; it puts increased pressure on them,” Wardrop continued. “The process was fairly user friendly before — the courts and the trustees and the debtors had reached a very good compromise on what had to be provided. Now the new code absolutely mandates certain documents, some of which debtors may not have.”

Hughes said there has been an effort to identify small businesses— businesses with non- contingent liquidated debt of less than $2 million — and specifically, small businesses that seek relief in Chapter 11.

“To the extent that there will be an impact, it will be with regard to this type of a small business, which would be a pretty significant number of businesses in this area that would be seeking relief,” Hughes said. “What I can’t tell you is what exactly are the limitations or restrictions that are going to be imposed upon them, because I haven’t looked at that aspect that closely. Apart from that, I haven’t seen any potential adverse impact.”

The bankruptcy reform is considered “creditor friendly,” because it’s supposed to make it easier for creditors to collect on debt. The U.S. Chamber of Commerce estimates American businesses are forced to absorb nearly $40 billion in unpaid bills every year due to bankruptcy filings.

Andersen said the reform doesn’t just make a Chapter 7 tougher for many people, it makes a Chapter 13 tougher for everyone. “I think there is going to be less money paid back to creditors under this law. The law is tough on Chapter 13 debtors, which means the millions or billions of dollars paid back to creditors in Chapter 13 will likely drop in the long run.”

Wardrop thinks creditors may be slightly better off under the reform, but that as a whole it won’t be that beneficial to them.

“The real people they’re going after will find a way around it,” he added. He thinks that over time, the reform may reduce the number of personal bankruptcy filings somewhat but doesn’t think it will have much, if any, affect on the volume of business bankruptcy filings.

As Hughes put it: “There certainly are provisions that have been enacted which would seem to me to create disincentives for filing a Chapter 7. Whether that’s going to have a material effect, who knows? It really is irrelevant what the bankruptcy judges think about the code. It will be the law of the land, and I, as well as the other judges, will enforce what Congress has enacted.”    

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